Question

The Bigbee Bottling Company is contemplating the replacement of one of its bottling

machines with a newer and more efficient one. The old machine has a book value of

$600,000 and a remaining useful life of 5 years. The firm does not expect to realize any

return from scrapping the old machine in 5 years, but it can sell it now to another firm in the industry for $265,000. The old machine is being depreciated toward a zero salvage value, or by $120,000 per year, using the straight-line method.

The new machine has a purchase price of $1,175,000, and estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $145,000. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. In total, an annual savings of $255,000 will be realized if the new machine is installed. The Company’s marginal tax rate is 35 percent and it has a 12 percent cost of capital.

a. What is the initial cash outlay required for the new machine?

b. Calculate the annual depreciation allowances for both machines, and compute the change in the annual depreciation expense if the replacement is made.

c. What are the operating cash flows in Years 1 through 5?

d. What is the after-tax salvage value of the new machine in Year 5?

e. What is the terminal year cash flow (CF5)

f. What is the NPV of the new machine? Should the firm purchase the new machine? Support your answer.

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

Home ert Page Layout Formulas Data Review V s Cut ta copy ▼ Format Painter Add-Ins Σ AutoSum , Fill В า 프. m. a-Δ. Ξミ 迣锂函Merge & Center. $, % , 弼皛Conditional Format. Cell. Insert Delete Format Paste Sort &Find & Formatting as Table Styles ClearFilter Select Clipboard Font dting Alignment Cells FW882 GB GC FU FV FW FX FY FZ GA GD GE GF 865 866 867 868 869 870 871 872 873 874 875 876 877 878 879 880 881 882 883 " ‘ ト llRR NPV IRR REPLACEMENT S HPR GMAM EAC MACRS LEASE RATIOCASHBUDGET L acc BOND STEIN ndfEPS EBIT | REPLACEMENT STats NPV-BETA LEVERED BIGBEE depreciation per year on old machine book value sale price- Loss on sale tax saving on loss on sale- 120000 note 265000 335000 117250 35% tax cost of new machine sale value of old machine tax saving on sale of old machine working capital 1175000 265000 117250 less less add 792750 intial cash flow at year 0 792750 멎园遛14..al t@ m木6 ENG 23-04-2019

Home ert Page Layout Formulas Data Review V Add-Ins Cut Σ AutoSum , aCopy Fill В า 프. m. a-Δ. Ξミ 迣锂函Merge & Center. $, % , 弼皛Conditional Format. Cell. Insert Delete Format Sort &Find & Format Painter Formatting as Table Styles ClearFilter Select Clipboard GC881 FU Font Cells dting Alignment FV FW FX FY FZ GB old machine change in depreciation depreciati GC GD GE GF 881 882 883 884 885 886 887 depreciation cost 1175000 rates year depreciation (S) on A-B 20.00% 32.00% 19.00% 12.00% 11.00% 235000 376000 223250 141000 129250 120000 120000 120000 120000 120000 115000 256000 103250 21000 9250 4 889 890 891 892 893 894 895 896 897 898 899 " ‘ ト TOTAL INCREASE IN EARNINGS 255000 incremental net cash flows yearEARNINGS(1-t) change in depreciation*(t) 1 255000 1-0.35) 115000 (0.35) 2 255000 (1-0.35)256000*(0.35) 3 255000 (1-0.35) 1032500*(0.35) 4 255000*(1-0.35) 21000*(0.35) 5 255000 (1-0.35)+9250 (0.35) 206000 255350 527125 173100 168987.50 llRR NPV IRR REPLACEMENT S HPR GMAM EAC MACRS LEASE RATIOCASHBUDGET L acc BOND STEIN ndfEPS EBIT | REPLACEMENT STats NPV-BETA LEVERED 09:14

Home ert Page Layout Formulas Data Review V Add-Ins % Cut aCopy Format Painter Σ AutoSum , 11 Arap Text Fill В า 프. m. a-Δ. Ξミ 迣锂函Merge & Center. $, % , 弼皛Conditional Format. Cell. Insert Delete Format Sort &Find & Formatting as Table Styles ClearFilter Select Clipboard Font Cells dting Alignment GD900 FV GC FX FY FZ GA GD GF GH 900 901 902 903 AFTER TAX SALVAGE VALUE OF NEW MACHINE BOOK VALUE OF MACHINE SALVAGE VALUE OF MACHINE PROFIT ON SALE OF MACHINE TAX ON PROFIT ON SALE AFTER TAX SALAVGE VALUE 70500 [1175000 X 6%] 145000A 74500 26075 B 905 906 907 908 909 910 911 912 913 914 915 916 917 918 " ‘ ト 118925 A-B 287912.50 TERMINAL YEAR CASH FLOW 168987.50118925 calcualtion of NPV cash floww pv factor @ 12% pv of cfat year 792750 183928.57 203563.46 375197.16 110008.18 163369.28 -792750 1 206000.00 2 255350.00 3 527125.00 4 173100.00 5 287912.50 0.8929 0.7972 0.7118 0.6355 0.5674 (168987.50 AFTER TAX SALVAGE VALUE) NPV 243316.66 YES, PURCHASE AS NPV IS POSITIVE lIRR NPV IRR REPLACEMENT S HPR GMAM EAC MACRS LEASE RATIOCASHBUDGET- w acc BOND STEIN ndfEPS EBIT | REPLACEMENT STats NPV BETA LEVERED 23-04-2019